The different types of insolvency

When a corporate tenant becomes insolvent, the landlord's rights depend upon the type of insolvency administration to which the tenant is subjected. Being familiar with the different options and the ways in which they are administered will enable property owners to act early and put themselves in the best possible position when faced with an insolvent (or potentially insolvent) tenant.

The three most common forms of insolvency administration which may affect corporate tenants are discussed below.

Voluntary administration

An administrator may be appointed by:

  • the board of directors passing a resolution that the company is insolvent or is likely to become insolvent at some future time (s436A of the Corporations Act 2001(Cth) (CA));
  • a liquidator or provisional liquidator if he or she thinks that the company is insolvent or is likely to become insolvent at some future time (s436B of the CA); or
  • a secured creditor who is entitled to enforce a charge on the whole, or substantially the whole, of a company's property (s436C of the CA).

Within weeks, the administrator must convene a meeting of creditors and provide what is commonly referred to as a 's439A report'. The s439A report is compiled by the administrator detailing the company's business, property, affairs and financial circumstances and must include a statement setting out the administrator's opinion about each of the following matters:

  • whether it would be in the creditors' interests for the company to execute a deed of company arrangement;
  • whether it would be in the creditors' interests for the administration to end (and return to business as usual); or
  • whether it would be in the creditors' interests for the company to be wound up (liquidated).

The report must also set out the administrator's reasons for those opinions, such other information to enable the creditors to make an informed decision, and if a deed of company arrangement is proposed, a statement setting out the details of the proposed deed. Generally the overriding factor to be considered is what option will result in the best return to the creditors.

Receivership

A secured creditor with an enforceable debenture or charge over an asset or assets of a company is entitled to appoint a receiver where the terms of the debenture and circumstances allow it. It has the effect of the receiver entering into possession of, or taking control of, the property of a company.

The appointment of a receiver is generally undertaken to protect the secured creditor's interests should a company's assets come under threat due to financial instability or insolvency. In certain circumstances, parties seeking to protect their interests may also apply to the court for a receiver to be appointed.

Any surplus funds or assets remaining after completion of the receiver's duties will be returned to the control of the company. Commonly, an administrator will have been appointed by this stage and it will be the administrator's responsibility to deal with the remaining funds or assets in the best interests of the remaining creditors.

Liquidation

Liquidation of a company may be commenced when a company is solvent or insolvent, and done voluntarily or by court order. The liquidator's role is to wind up all of the affairs of the company, which often involves realising the company's assets to ensure the best returns to the creditors.

If the company is insolvent, meaning it is unable to pay its debts as and when they fall due, then it may be wound up:

  • where the members or directors of the company have resolved to wind up the company, subject to the control of the creditors (creditors' voluntary winding up); or
  • on the application by the company, a creditor, a contributory, the liquidator, ASIC or APRA to the court to wind up the company pursuant to s462 of the CA (compulsory liquidation).

A solvent company may be wound up in any one of the following situations:

  • for reconstruction purposes for a group of companies;
  • where the assets of the company are sold rather than the shares, leaving a dormant company shell;
  • where it is just and equitable to do so; or
  • in hostile circumstances, where the conduct of a company's affairs, company actions or a resolution is contrary to the interests of the members or is oppressive to, unfairly prejudicial to or unfairly discriminatory against a member or members of the company.

These situations may also be either voluntary or compulsory.

However, no matter the reason for the liquidation the ultimate outcome is the same - the existence of the company comes to an end and the company is deregistered.

Common questions

Is the lease automatically terminated if the tenant is subject to an insolvency administration?

Often the terms of a lease will allow the landlord to terminate the lease where the tenant is subject to an insolvency administration or other "insolvency event" (generally defined in the lease).

If the tenant is placed under administration, the landlord cannot take possession of the property or otherwise recover it unless the landlord obtains the administrator's written consent or leave of the court, in accordance with s440C of the CA.

Where a receiver has been privately appointed, leases or contracts are not automatically terminated. A receiver, acting as agent of the company, may repudiate the contract if it is of no advantage to the company, but should be aware the receiver may then be liable for damages.

However, where a receiver is court-appointed, contracts that impose active obligations on a company are terminated.

If a tenant company is in liquidation, the lease will remain in force unless it is specifically disclaimed by the liquidator in accordance with s568 of the CA, or terminated by the landlord in accordance with the terms of the lease - which will usually contain a provision to that effect.

Can the landlord recover rent?

Among the most important issues for a landlord when their tenant becomes subject to an insolvency administration will be their ability to recover rent.

Briefly:

  • Administrators are liable to pay rent for any period (beginning five days after the administration begins) throughout which the company continues to use, occupy, or be in possession of the property and the administration continues under s443B(2) of the CA, unless the court excuses them from liability (such an application will only be granted in limited circumstances).
  • A tenant company will continue to be liable for rent even when a receiver has been appointed, unless that receiver has done something to demonstrate that he or she has assumed personal responsibility, or has incurred the debts expressly or by necessary implication. If so, the receiver will then become personally liable for the rent.
  • As liquidators assume control of the company, replacing the directors, any debts that continue to be incurred are treated as those of the company and the liquidator is not generally held to be personally liable for rent.

Arrears of rent (for the period before the tenant became subject to an insolvency administration) cannot be recovered from an administrator, receiver or liquidator. The landlord will generally have no choice but to prove as an unsecured creditor.

In addition, due to an automatic stay on legal proceedings in administrations (s440D of the CA) and liquidations (s471B of the CA), a landlord cannot commence or proceed with legal action against a tenant company unless it obtains the consent of the administrator (in the case of an administration) or the leave of the court (in relation to either an administration or a liquidation). Leave will be granted only in rare circumstances.

Unlike administrations and liquidations, receivership does not cause an automatic stay on legal proceedings. Therefore tenant companies under receivership may be sued for arrears of rent or damages, or the landlord may enforce a provision for re-entry if the terms of the lease allow.

Who gets the fit out?

If the tenant is under administration, the landlord can only recover property in the tenant's possession (including fit out belonging to the landlord) if it has the consent of the administrator or has obtained the leave of the court. These restrictions do not apply if the landlord took possession of the premises before the date the administration commenced under s441F of the CA.

The landlord can generally recover its fit out if the tenant is in receivership (where the landlord holds a charge over that property) or liquidation, as the company is prevented from dealing with that property.

Can the landlord terminate and re-enter?

As previously discussed, most commercial leases will contain a provision allowing the landlord to terminate the lease in the event that the tenant becomes subject to an insolvency administration or other insolvency event as defined in the lease.

If the tenant company is under administration, the landlord is still entitled to give a notice terminating the lease, but unless the court or the administrator consents, it cannot recover possession of the leased premises until the administration is completed.

It appears that this moratorium on recovery of the premises will apply even if the administrator itself is in breach of the lease - for example, if the administrator remains in possession of the premises but fails to pay rent. In such a case, the landlord's only remedy would be to pursue the administrator for recovery of rent.

Any rent received from an administrator after termination by the landlord but prior to the recovery of possession should be specifically acknowledged by the landlord as receipt of "mesne profits" (rather than rent). This will avoid any argument that the acceptance of rent has created a new lease.

Where the tenant is under receivership or in liquidation, the landlord may terminate and re-enter if entitled by the terms of the lease. The notice of termination should always be served on the receiver or liquidator as well as the tenant.

Put yourself in the best possible position

When entering a lease

Always take additional security in relation to a lease - cash bonds or bank guarantees are the safest option, as personal guarantees from the directors can be worthless if guarantees have also been given to other creditors.

Once the lease is in force

Act early to claim on any security held and, if necessary, take possession of the premises if it appears that a tenant is experiencing serious financial difficulty (assuming there has been a default entitling termination of the lease). This will enable the landlord to take steps to re-let the premises before its rights to do so are restricted by any insolvency administration.

If the tenant becomes subject to external control

Always deal with the administrator, receiver or liquidator in the first instance as the directors will no longer have the power to bind the company (this is not always the case in a receivership). And get in contact early - being kept "in the loop" will enable the landlord to take steps to minimise its loss by, amongst other things, re-letting the premises as soon as possible or coming to a mutually beneficial arrangement with the administrator, receiver or liquidator.